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Monetary policy implementation and the Federal Reserve

1. What type of monetary policy has the Federal Reserve been using for the past year (easy/expansionary, tight/contractionary, or neutral/non-involvement)?

2. Why have they been using this policy?

3. How have they implemented the policy (changing the "interest rate", changing the reserve ratio, or open market operations)?

4. How has this policy impacted you and/or your company(retail electronic sales)?

Solution Preview

1. For the past year, the Fed has been using tight/contractionary monetary policy.

2. Concerns about inflation are the reason the Fed uses this policy. Inflation occurs if the economy grows too quickly. When the Federal Reserve adopts a restrictive monetary policy, it sells bonds in order to reduce the money supply. This results in higher interest rates and less spending. A restrictive monetary policy will decrease inflationary pressures, but it may also decrease investment spending and cause real gross domestic product to decrease or to increase more slowly.

3. Open market operations are the primary tool of the Federal Reserve, and is quite powerful. This is what the Federal Reserve actually does when it announces a new target for its federal funds rate. The federal funds rate is the interest rate banks charge one another in return for a loan of reserves. If the supply of reserves is reduced because the Federal Reserve has sold bonds, that interest rate is likely to increase. If the supply of reserves is increased because the ...